Seth Klarman is one of the world’s most successful value investors. His Baupost hedge fund has achieved outstanding returns for investors over the years and currently manages just under $20 billion in client money.
However, despite his success over the years, Klarman is relatively media-shy and barring the publication of his book, Margin of Safety: Risk-averse Value Investing Strategies for the Thoughtful Investor
Baupost: Making Use Of Market Inefficiencies To Find Bargains In Distressed Debt
This means that any commentary from Klarman is highly valued and his insights are always worth reading. The following is a summary of Seth Klarman’s investing process as detailed in an interview with Barron’s 4 November 1991.
Finding your own ideas is key
Every investment starts at the research stage. Without an appropriate amount of research, an investment is probably doomed from the outset. Klarman is well known for his in-depth research process, and he highlights in the interview how important it is for an investor to conduct all of their own research, rather than relying on other people’s ideas. Anyone can buy a stock just because someone else recommends it, but if you haven’t done the research yourself, it’s difficult to maintain conviction if the market moves against you. Moreover, if you didn’t have a set plan going into the trade, you can’t learn from your mistakes.
Klarman Calls Out Public "For Profit" Hedge Fund Model
You can learn more from a losing trade then you can a winning one.
Seth Klarman on searching for ideas
According to the interview, Klarman finds most of his ideas via internal discussions with Baupost employees. These ideas in turn come from newspapers and magazines. And when deciding which ideas deserve further research, there are two categories of investment Klarman is on the lookout for:
- Market inefficiency or imperfection to developments that are usually caused by institutional constraints. For example, many institutions have moved away from fundamental investing, which has opened up many opportunities for the fundamentally driven contrarian value investor.
- “Rocks to look under.” When securities get downgraded from investment grade to below investment grade and are universally dumped by funds following them without any consideration to the fundamentals. Once again, this is making use of market inefficiencies.
While Klarman is not a macro driven investor, he does consider macro issues. Within the Barron’s interview he comments that unlike many other firms, which rely on Wall Street forecasts put together an economic outlook, Baupost builds its view of the economy by talking to other investors and company management teams— a simple approach but one that gives a more realistic view of the economy and its underlying trends.
Still, if the opportunities are there to be taken Baupost will invest, even if the economic environment is not perfect.
It seems the most part, Klarman invests where others are afraid or not allowed to tread. Ultimately, Baupost is taking the opposite side of the trade to skittish institutional investors who are judged on quarterly results, constricted by strict investment guidelines and are easily swayed by investment fads. These “fully invested bears” as Klarman calls them are the perfect opportunity creators for Baupost and it’s investors:
“I think the market is just as vulnerable to a sudden correction, and a very sharp sudden correction. For one thing, as I said, I think we have a market of fully invested bears. The institutional investors, being short-term and relative-performance oriented, are trying to all beat each other every three months, and hence will react to which ever direction the market is going in. As long as the market is generally flat to rising, they will stay in the market. But if they perceive that the market is going down -- in other words, if the market starts to go down -- they may all decide to get out at once, none of them wanting to be in longer than anybody else. We have put on a few circuit breakers, but they don't address the fundamental problem of professional investors who feel compelled to stay in and hold overvalued securities.” – Source: Seth Klarman: 4 November 1991 Barron’s interview
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